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Chet Currier

Old favorite money-market mutual funds making strong comeback

Email|Print|Single Page| Text size + By Chet Currier
May 3, 2007

Move over, hedge funds. Step aside, exchange-traded funds.

Make some space for another money-management vehicle that has been piling up assets lately at an impressive pace, though with far less accompanying hype. We're talking growth of almost $600 billion, or 33 percent, in less than two years to more than $2.4 trillion at the end of March.

The hot property in question is the money-market mutual fund, a great success story of the 1970s, '80s, and '90s that is back for an encore.

Money funds are conservative investments with historically modest returns, and they will never be much for glamour.

But, thanks to a persistent condition known as an inverted yield curve, money funds and other types of short-term interest-bearing investments offer better yields than longer-term bonds.

Yields at the 100 largest money funds, with holdings typically due to mature in a little more than a month, averaged 4.98 percent at last report from researcher Crane Data LLC. That compares with 4.65 percent on two-year Treasury notes, and 4.69 percent on 10-year Treasury notes, as of the end of last week.

By all the standard models, longer-term loans ought to command higher interest rates.

Even if they didn't offer a yield advantage, money-market investments, or "cash" in Wall Street parlance, would carry considerable appeal right now as a haven from risk. Bonds, as we have just seen, aren't priced to reflect the extra risks of inflation and interest-rate fluctuations that come with their longer lives. Riskier assets, from junk bonds to small-company stocks, also trade with little or no cushion.

"The risk premium has reached a historic low everywhere," says Jeremy Grantham, chairman of Grantham, Mayo, Van Otterloo & Co., a Boston-based manager of $141 billion. "Global credit is more extended and more complicated than ever before so that no one is sure where all the increased risk has ended up."

People concerned about this kind of generalized threat may turn to other types of shelter -- gold, for instance. Gold, it should be noted, isn't exactly going cheap itself, having climbed about 50 percent in price in the last two years.

If economic troubles struck hard at high-riding industrial and commercial commodity prices, might that not exert a powerful drag on the price of gold as well?

In extreme conditions, the money market itself would hardly be immune from risks. For the greatest possible protection against defaults, some investors prefer the direct purchase of Treasury bills or insured bank deposits rather than money-market mutual funds, which aren't covered by federal insurance.

And non-US owners of any dollar-denominated investment, including Treasuries, always have the effects of currency fluctuations to contend with.

On a less cosmic scale, money-market investors face the ever-present possibility of a decline in short-term interest rates that might leave them wishing they had moved to longer-term bond yields instead.

Bill Gross, manager of the biggest bond fund, the $103 billion Pimco Total Return fund, says the Federal Reserve "will cut rates and cut them significantly over the next few years in order to reinvigorate an anemic US economy."

Ian Shepherdson, chief US economist at High Frequency Economics in Valhalla, N.Y., says he expects the Fed to cut its target rate on overnight bank loans, known as federal funds, to 3.75 percent by March from the current 5.25 percent.

In that event, money-fund investors could expect to see their yields fall, with a short lag, to about 3.5 percent, or 30 percent below where they stand now.

Those forecasts, let us hasten to add, are toward the outer edge. In the most recent monthly Bloomberg survey of 66 economists, the median forecast for the federal-funds rate in the first quarter of next year was 5 percent. A few analysts even look for the rate to go higher, to as much as 6 percent.

For now, the Fed seems content with the balance it has struck between the opposing threats of inflation and recession. Money-market investors are acting pretty happy as well.

Chet Currier is a Bloomberg News columnist. He can be reached at ccurrier@bloomberg.net.

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